Business History Lectures 6-10 Flashcards
Lecture 8
The Changing Relationship between Business, Finance and Government I
When have we drawn attention to the state for business thus far?
- The development of technology.
- Industrialisation in Japan
- WW1.
Quote by Joan Robinson 1952
“where enterprise leads finance follows.”
Quote by Merton Miller 1988
“[the idea] that financial markets contribute to economic growth is a proposition too obvious for serious discussion.”
What are the recent vies on the consideration of the financial system?
theories of growth are incomplete without a consideration of the financial system.
What are the Five Functions of the financial System?
- Produce information ex ante about possible investments and allocate capital
- Monitor investments and exert corporate governance after providing finance
- Facilitate the trading, diversification, and management of risk
- Mobilise and pool savings
- Ease the exchange of goods and services (reduce transactions costs).
Quote by Levine 2004 about the functions of financial systems?
Levine - “While all financial systems provide these financial functions, there are large differences in how well financial systems provide these functions”.
What two systems are used for finical services?
‘bank based’/concentrated ownership and ‘market based’/dispersed ownership
systems.
What countries tend to focus on market based systems?
US and Britain.
What financial system requires a complementary institutional structure and what does this involve?
The dispersed ownership system (market based). It involves:
1. Strong securities markets
2. Rigorous disclosure standards
3. High market transparency.
Market for coronet control constitutes the ultimate disciplinary mechanism.
What is the final conclusion about what is better between dispersed ownership and concentrated ownership?
The implications for economic performance are far from clear-cut, and it may be that different governance systems ‘fit’ different technologies or production better than others. A bank based system, such as the one in Germany, tends to be more lasting, with US being more about boom and bust.
Why is there a difference between dispersed and concentrated ownership model?
The informational role of the stock market. There appears to be a strong polarization between concentrated ownership/bank based models and diffused ownership models.
What is the free rider problem involved with dispersed ownership?
The monitoring of management functions like
a public good for all shareholders –whoever does the monitoring incurs costs but all shareholders benefit.
What is the main problem with diffused ownership?
Diffused ownership offers little possibility for direct influence on management by
individual shareholders.
What needs to be the case for even small share holders within dispersed ownership models?
Small equity-holders need to able to ‘exit’ if they don’t approve management
actions and this requires liquid stock markets for shareholders to sell their equity
-both the UK and the US have stock markets whose valuation of companies is far
greater than annual GDP
What are the implications on market performance for dispersed ownership systems?
Far from clear-cut. It may be the case that different governance systems ‘fit’ different technologies or production better than others.
What are the ownership patterns like in Britain and America?
Very diffuse ownership patterns.
What is a key difference between the US and UK?
In Britain, institutional investors and insurance funds are strong and take-over bids are common.
What is the situation of ownership concentration in the US?
- Some powerful concentrations of ownership do exist among ‘second tier
business’ but not in Fortune 100 or 200 - In the United States “active boards bargain with bidders, motivated by fiduciary duties, stock options, severance pay packages, and other
considerations. In the United Kingdom shareholders rarely litigate”
[Bechtand Delong 2004 p 614). - Moreover, the current pattern emerged only in the last century. At its outset large swathes of industry were controlled by powerful individuals and families such as the Rockefellers acting through financial intermediaries such as JP Morgan.
When did the erosion of concentrated ownership occur in the US?
1900-1930.
What but shift did the US make with regards to concentrated ownership?
A shift from a
concentrated ownership structure to a diffuse ownership pattern in the early
decades of the last century.
Why does Roe stress as being important in the US’ ownership situation?
To explain why any individual economy’s pattern of ownership and governance
has evolved, Roe has stressed the importance of political factors and whether
governments favour ‘stakeholders’ or the legal rights of shareholders.
Erosion of concentrated ownership - Stakeholder?
Stakeholders may include families, employees or banks who act as so-called
‘block-holders’ who may closely monitor management and reign in
management discretion
Erosion of concentrated ownership - US forces that were prominent during early 20th century and the result following the Wall Street Crash?
Democratic/ progressive/ antitrust political forces. These forces triumphed after the ‘Wall Street Crash’ of 1929 in the form of the
New Deal.
What role did investors have prior to WWI?
In the years prior to WWI, investment bankers played a very prominent role
in US industry -handling securities issues andserving on boards of directors;
It is estimated that by the eve of WWI, these institutions were major shareholders,
directors or trustees of corporations ‘worth one and a half years’ national product
and 40 percent of the country’s produced capital’ (J. Bradford de Long p. 205)
What was the main investment bank out of the few that were prominent in the period prior to WWI in the US and what was the controversy around this?
JP Morgan.
The fact that the banks made enormous profits has created considerable
controversy as to the source of these profits
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Tobin’s q?
Tobin’s q = Market value of an individual firm’s assets/ replacement cost of the same firm’s assets.
The former being its value one the stock exchange and the latter being its book value.
What does J. Bradford Delongs paper investigate?
Whether the JP Morgan men created value for the firms in which they had an interest. He looked into Tobin’s q. If it rises above 1 then this indicated that the firm possesses some asset which is not recored by conventional book values.
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What were the consequences of the Wall Street Crash?
-Perhaps erroneously, it is often blamed for the Great Depression post 1929. - But it marked a great political turning point, ensuring the triumph of FDR and the New Dealers in 1932 Presidential election . - An important element in the deal was financial regulation
Post 1929 US Financial Regulation?
- Considerable effort to increase trust in capital markets resulted in several regulatory Acts in the following years
- The Securities and Exchange Commission (1935) formed under Joseph P. Kennedy
- Regulation of:
1. Margin trading
2. Information disclosure by companies
3. Use of insider information - Separation of investment banks from commercial banks (Glass-SteagallAct)
- After some decades, unwinding of some regulation in Reagan era and after, although information disclosure and insider trading regulation continue to be important
What conclusions can we draw from Finance in the US?
- The relationship between finance and the ‘real economy’ is important –not
just in terms of channelling savings into profitable investments, but also
in terms of the monitoring of management which has become separated
from ownership. - This may explain the degree of polarisation between concentrated ownership and diffuse ownership systems; in the latter stock markets play an important informational role and the extent to which stock market prices correctly guide both investors and managers is crucial.
- The business history of the US suggests that political forces are important in
shaping financial systems with both anti-trust sentiment and the Wall-Street crash
of 1929 being important determinants of the developing corporate governance system of the US
Britain: The ‘City’ and its role before/during/after WWI?
The financial institutions have often operated largely independently of domestic business, at least with respect to longer term finance.
Before WWI, the City was very important in channelling funds into overseas investment. During and after WWI, restrictions on capital exports a continuing feature, while access to external capital became much more important
for domestic business, often through new share issues (see Wilson chapter 6).
Britain: The ‘City’, personal capitalism and results of changes?
- The significance of family ownership and Chandlerian type ‘personal capitalism’ declined rapidly during the course of the last century. Acquisition activity financed by new issues diluted ownership, reducing ownership concentration.
- In the UK more than anywhere, this made large family-owned businesses
vulnerable to ‘hostile’ take-overs. According to Franckset al1, the City and institutional
made it difficult for families to retain control, eventually making the ownership pattern in the UK far more diffuse than anywhere else in the world (inc.US)
Why is the US a more effective competitor than the UK after WWI?
It already has big business, whereas the UK is only just creating them.
Slide 16 J. Francks Paper
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How do Government and businesses interact? (5)
- As a consumer (e.g. military purchases)
- In establishing/updating legal framework for business
- In raising taxes
- As an owner (e.g. until recently the Royal Mail)
- As a provider of information (e.g. GDP figures, censuses)
What specific policy interventions do the Government interact with businesses?
- As a defender of interests (e.g. low paid, unemployed, disabled etc.)
- In preventing monopoly or abuse of monopoly
- In securing ‘strategic’ interests
Types of industrial policy table (third IR)?
Look at notes
Horizontal policy instrument examples? Product Labour and Skills Capital Market. Land Technology
Product: Competition policy Indirect tax Product market regulation Exchange rate policy
Labour and Skills: Educational Policies Training subsidies Wage subsidies Labour market regulation Employment taxes
Capital Market:
Corporate tax policy
Financial market regulation
Land:
Land use planning rules
Infrastructure policy
Technology:
RandD Tax Credit
IPR (intellectual property rights)
Selective policy instrument examples? Product Labour and Skills Capital Market. Land Technology
Product: National Champions State Aids Nationalisation/ Privatisation Trade policy Public procurement
Labour and Skills:
Targeted skills policy
apprenticeships policies
Capital Market:
State investment bank
Strategic investment fund
Emergency loans
Land:
Place-based cluster policy
Enterprise zones
Technology:
Public procurement
Selective technology funding
What does Adam Smith Outline with regards to the role of government in business?
-Restricted Role for Government Defence
- Justice
- Certain public works
A starting point in the Smithian tradition resides in the idea of ‘microeconomic’ market failure
Alternative views in the role of the state in business than Adam Smith’s?
- Karl Marx and other socialists have advanced the possibilities for collective ownership. In Britain Fabian (non-revolutionary) socialism has been an important influence on the Labour Party in Britain (at least until recent times)
- John Maynard Keynes emphasised defects in the capitalist system and its failure at a macroeconomic level to generate full employment and which required government intervention
- Corporatism. Cooperation between ‘big-business’ and the state.
What is the Market Failure case for Industrial Policy and what are the preventative measures? (5)
- Monopoly and market power –competition policy
- Natural monopolies –state ownership or regulation
- Learning and externalities -infant industries policies
- Externalities in innovation – technology policies:
Such as public R&D, support for R&D, Intellectual Property Rights (IPR) - ‘Sub-optimal’ industrial structures resulting in failure to achieve scale economies or critical mass of R&D –creation of national champions
Rationalization?
A further important ideology that emerged in the 20th century was that of
corporatism, an idea closely related to that of ‘rationalization’.
Corporatism?
Corporatism can be regarded as an alternative to both Socialism/Marxism and
liberal market capitalism and in which there is a close relationship between
big business and the state acting cooperatively to secure ‘the public interest’.
Where is corporatism not in the public interest?
Environmental safety laws.
What, in Britain during the inter-war period, led to the development of corporatism?
Increasing business concentration, increasing
protectionism and continuing labour unrest, all favoured the development of
corporatism. Bodies such as the Federation of British Industries (FBI) became important lobbying groups for business
What is is the variant of corporatism that emerged in Britain and what is it?
Tri-Partism: Brings organised labour (trade unions) into the picture. They were important during WWI due to the cooperation with union movements.
What were and early example of tri-partism in Britain?
The Joint Industrial Councils
What is a case of early Corporatism in Britain?
Imperial Chemical Industries. It was a ‘national champion’
Case Study: ICI - Name and what is it an example of?
Imperial Chemical Industries.
A pioneering case of state-business cooperation. The government backed merger in 1926 of 4 companies.
Case Study: ICI - Companies involved?
Brunner-Mond, Nobel Industries, United Alkali and British Dyestuffs Corporation
Case Study: ICI - Reason?
It was a strategic response of government and big business in a relatively weak British Chemical Industry to the creation of IG Farben in 1924. It may be regarded as an early example of the creation of a ‘National Champion’ in what was considered by business and government as a ‘strategic Industry’.
What is the role of the national champion?
The governments interests are ahead of those of the individuals financing the company through investment.
Why were National Champions established in Britain?
In order to competed with the dominant US and German Industries.
When did the policy of National Champions develop and why?
A pervasive belief in Britain in the 1960s (and elsewhere in Europe) was
the idea that British business could only ‘compete’ in world markets (and more particularly with US enterprise) if individual enterprises achieve a certain ‘critical mass’(e.g. through traditional economies of scale in production or because of the fixed costs associated with R&D) and that the resultant competitive firms operate in certain ‘strategic sectors’
Who points out the case of national champions and what were his three main points?
Paul Geroski (2005) pointed out the case generally rests on 3 propositions:
1. That markets are ‘global’ i.e. demand is very homogeneous
2. That economies of scale/critical mass are large in relation to national
markets
3. That a national presence is important in certain strategic sectors that
are “particularly rich input-output hubs…[and whose growth] likely to
stimulate growth in a wide range of complementary sectors”.
What was the outline of Geroski’s view of National Champions?
Global demand is far less homogeneous than
commonly supposed and markets are often fragmented on national lines. The vast majority of brand names are national and rarely have much pill beyond their home market.
National Champions - the case of Marlboro and the rebuttal
Some would argue that the case of Marlboro being a global brand means the tobacco is a global market. Yet, Geroski points out that the world tobacco industry is largely populated by many national brands that no one has ever heard of outside of their home market. Marlboro proves that is is possible to conduct a global strategy in this business, but it does not prove that you have to.
National Champions - How important are conventional economies of scale in relation to national markets?
Studies based upon the concept of MES have tended to show that only in a few industries are economies of scale large in relation to national market size.
For example in only a small number of industries in which MES is greater than
10% of the British market, while EU studies suggest that in 89% of industries MES is less than 10% of the EU market.
Need to memorise diagrams MES: Y axis - Average costs
X Axis - Flow of Output.
National Champions - strategic sector significance and Geroski’s and the OECDs views on National Champions?
A strong domestic presence in come technologies may be important for widespread technological change (as we have seen with GPT).
Geroski is concerned with the implication of monopolies in the form of national champions on competition (as he was the head of the UK Competition Commission), pointing out that critical mass (referring to adequate RandD and innovation in these sectors) can be achieved through clusters, as seen in Silicon Valley. OECD concur with this view, highlighting that the trade off between the creation of a national champion and a fall in competition is large, and that evidence for ‘the bigger the better’ is very weak.
There is also a fear of foreign ownership.
National Champions - What development came in the 1960s with National Champions and what does Wilson note about this?
The Industrial Reorganisation Corporation (IRC) in the post war heyday of national champions.
Wilson (1993) notes various cases where the IRC promoted mergers of nationals significance in the late 1960s:
-British Leyland (BMC-Leyland)
-GEC/Elliott Automation
-GEC/Associated Electrical Industries
-International Computers Limited (ICL) -ICT and Elliott Automation
- He contrasts the BMC merger unfavourably with the ‘successful - despite going bust after two years of Wilson writing his book’ GEC mergers.
ICL a rather ‘mixed bag’ - it no longer exists due to the cheapness of imports in electrical..
Nationalization in Britain (1945-51) - Governments and their policies?
- Although there were pre-war examples of public ownership, this was often in
the form of municipal enterprise (e.g. water, tramways…) , it was the
Labour Government of 1945-1951 which engaged in extensive nationalisationof
British industry with both ideological and industrial policy rationales - Many of these not seriously opposed by Conservatives and on return to power
in 1951 they denationalised only iron and steel and road haulage, although they
favoured more decentralised management structures
Nationalization in Britain (1945-51) - Rationals?
- Network ‘natural monopolies’ –telecoms, railways, electricity, gas, water where efficiency considerations suggest a single supplier is better.
- Control of ‘commanding heights of the economy’ (economic planning)
- Resolution of labour problems (e.g. coal)
- Stimulation of technological change (e.g. coal).
Nationalization in Britain (1945-51) - Challenges?
- Often the merger involved many small units (e.g. individual mines, municipal electricity establishments etc.) with no existing large central organisational capability. Britain didn’t have a particularly great education system suited for this.
What were the two key government in Britain post war and what were their polices?
- The Labour Government of 1945-51 which embarked on a considerable ‘experiment’ in nationalization
- The Conservative administration of 1979-1997 which eventually
reversed this process via a process of privatisation
Nationalisation - What respective countries’ share of state owned ownership is?
France is the best with 14.6% employment and 16.5% output.
The UK has 8.2% of employment and 11.1% of output.
Today, France still has around 20% of output, whereas the UK has about 2%.
Britain - The public corporation?
Has an independent legal identity, and was based on taking an ‘arms-length’ relationship between government and management with the relevant government minister responsible for ‘broad objectives’ while management were responsible for the running of the corporation.
A government minister makes appointments to Board.
They are financially independent. Corporation keeps surpluses and can borrow from external capital makers (backed by HM Treasury guarantee).
Most external financing from Exchequer via a ‘National Loans Fund’ - but very little money paid back into this fund.
Public Corporation - Accountability and control?
- By the 1960s, there was growing dissatisfaction with the performance
record of the public corporation, although the evidence is somewhat mixed. - The ‘control’ problem was widely recognised. While model creators envisaged a separation between ministerial responsibility for strategic objectives and management responsibility for day to day operations,
in practice this was not achieved, with ministers frequently intervening in
management decisions.
Public Corporation - Accountability and control - Examples?
Interference in pricing decisions in inflationary environments, limiting energy price rises. The UK government held down the cost of electricity below the mc.
Public Corporation - Corrective measures?
In the 1960s corrective measures were implemented, including the setting of ‘financial targets’ for each corporation.
1967: A set of objectives set in place:
(i) Prices reflecting long-run marginal costs
(ii) Rates of return on investment should exceed a ‘test discount rate’
(iii) avoidance of cross-subsidization
Public Corporation - What was Leslie Hannah’s view on their efficiency?
In Leslie Hannah’s view, the efficiency of the public corporation was frequently
hindered by forms of ‘technological nationalism’ which constrained management to make technological choices which favoured British owned technologies.
Public Corporation - What were the two prime examples supporting Leslie Hannah’s view of efficiency?
- The prime example here is in the development of nuclear power in Britain –and
the case of the Advanced Gas Cooled Reactor (AGR) - The AGR and the development of the supersonic passenger airline Concorde have been shown on cost-benefit grounds to constitute two substantial industrial policy failures.
Government intervention -Nationalisation of Private Companies ‘in Difficulty’?
By the 1970s, there was an additional reason for nationalization –private
Companies which found themselves in financial difficulty. The government didn’t want them to go bust due to losses in employment.
Government intervention - nationalising private companies successful examples?
Rolls-Royce nationalisation in from 1971-1987 enabled the development of a highly competitive aero-engine maker. The reason for nationalisation stem from an inability to secure short-term financing.
British-Leyland created by the government to be a national champion in motor vehicles. Continuing difficulties led to its nationalisation in 1975.
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Public Corporation Performance compared to Private -Profitability
If rates of return on capital are compared, they were roughly 3 times as large
in large private sector firms in the period 1970-1985, i.e. largely before the big
privatization programme instituted by the Conservative administration.
Net negative return out of investing in public comapnies
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Lecture 6
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What period do we focus on for Big business in the 20th century?
Big business in the 20th century. 1914-1939
What are the four important headings we follow in explaining why there was a persistence of competitive advantage by businesses that survived past WWI? (4)
- Patterns
- Strategies and organization for growth (the innovation of the M-form)
- The legacy of WW1 and the role of the state
- The role of ‘first mover advantages’ in sustaining big business
What is the significance of businesses that survived through and past WWI?
They tended to keep their competitive advantage over others.
Global big business in 1913 - different countries big business sizes?
- The largest US businesses in 1912 were considerably larger than those
in either Germany or Britain - Largest British Firm in 1912 less than half size of US Steel
- J&P Coats (UK - textiles) formed from acquisition of several firms in 1896 but
represented the industries of the First Industrial Revolution
